Posing the problem of solving the foreclosure crisis first begs the question – “is there really a foreclosure crisis?”
The country is certainly in crisis, but the crisis is not being caused by mortgage foreclosure. Foreclosure is simply a mechanism for people to deal with a debt they can no longer afford. Rather than being a crisis, the potential onslaught of home foreclosures (which has been slowed somewhat by the Obama administration’s “Making Home Affordable” program) is actually market forces hard at work cleaning out the mess in the real estate market caused by too much cheap money loaned to people who were not sound credit risks to buy homes they could not afford. When home prices are completely out of line with wages and people who would normally have a hard time getting a friend to loan them $20 are able to take out interest-only loans to buy over-priced housing, something is very, very wrong. While it may be painful for many people, the real estate market collapsing, including thousands of inevitable foreclosures, is not a crisis, but rather a result of the real crisis – unserviceable debt.
Years of cheap credit, combined with government incentives to get people to purchase homes, debt securitization that hid the risk of low quality loans, and Government Sponsored Entities (GSEs) that lowered standards for purchasing mortgages created a situation that compelled lenders to make riskier and riskier loans. Individuals who had formerly not been able to purchase homes had access to credit like never before. With more and more people buying houses, prices soared and real estate looked like a sure-fire way to make money. Adjustable rate loans or loans with a huge balloon payments were not seen as potentially unaffordable as long as the house was sold before the loan’s low-interest period was over. At the rate home prices were accelerating, a handsome profit could be made with lightening speed, so the long-term consequences of adjustable mortgages didn’t even need to be considered.
But of course, they did need to be considered. Like any pyramid scheme, more people have to keep buying in for money to keep being made. As the pool of potential borrowers got smaller and smaller, eventually someone was going to be left with a mortgage they couldn’t afford. And because of the nature of this particular scheme – those people with the worst credit risk and highest likelihood of default being swept into the market at the end – those stuck with a house they couldn’t sell were also the most likely to default on their loans.
Which leaves us where we are today – with housing prices way above average incomes and people in far, far too much debt. As with virtually every agreement made in real estate, the collateral for the loan is the property itself. When a borrower can’t pay his mortgage, the bank can foreclose. And rather than being a crisis, this is actually a good thing.
Why? Because it gives the market an opportunity...